Financial Restructuring– Corporate Restructuring, Insolvency, Liquidation & Winding-Up Important Questions
Question 1.
XYZ Ltd. is a company listed on the National Stock Exchange. The latest audited financial position of XYZ Ltd. is as under –
Paid-up Equity Capital ₹ 442 crores
Free Reserves ₹ 20,347 crores
Total Secured & Unsecured Debts ₹ 1,275 crores
The company intends to buy back its fully paid-up equity shares of ₹ 5 each, not exceeding 20,585,000 equity shares at ₹ 950 per equity share payable in cash for aggregate consideration not exceeding ₹ 1,955.57 crore. Examine whether the above buy-back offer through tender route can be approved by the Board of Directors, keeping in view the provisions of the relevant SEBI Regulations and Companies Act, 2013.
Answer:
As per Section 68 of the Companies Act, 2013, the Board of directors can approve buy-back upto 10% of the total paid-up equity capital and free reserves of the company. Such buy-back has to be authorized by the board by means of a resolution passed at the Board meeting.
A buy-back of equity shares can be sanctioned by the shareholders through a special resolution upto 25% of the total paid-up equity capital and free reserves of the company.
A company can buy back maximum 25% equity shares out of the fully-paid up equity shares
Further, the ratio of the total long-term debts owed by a company after buy-back should not be more than twice the paid-up capital and its free reserves i.e. the ratio shall not exceed 2:1.
In the given case, the paid-up equity capital and free reserves is ₹ 20,789 crores (₹ 442 crores + ₹ 20,347 crores) whereas the total secured and unsecured debts amount to ₹ 1275 crores, per the latest audited financials.
The Board of Directors can buy back up to 10% of ₹ 20,789 crores, i.e. ₹ 2,078.90 crores. Here, the Board plans to buy back equity shares amounting to ₹ 1,955.57 crores, which is well within the maximum permissible limit. Hence, the Board can authorize through a resolution passed at its meeting to buyback of shares.
Post-buy-back scheme for ₹ 1,955.57 crores, the company’s reserves would reduce as well as its paid-up equity capital would reduce. Hence, its paid-up capital and free reserves after buy-back would become ₹ 18,833.43 crore. Thus, the debt-equity ratio after buy-back scheme has been fully completed would be 0.068 (1275/18,833.43), which is less than the stipulated Hence, XYZ Ltd. can proceed with the proposed buy-back scheme by passing a resolution passed at the Board meeting.
Question 2.
You are the Company Secretary of PQR Ltd. The Board of the company is opting for reduction in the share capital of the company without seeking the approval of the Tribunal. How would you advise the Board?
OR
Question 3.
“Reduction of capital requires the approval of National Company Law Tribunal (NCLT) is a general perception.” Elucidate.
Answer:
As per Section 66 of the Companies Act, 2013, sanction of the NCLT is required for effecting reduction of any paid-up share capital.
However, there are circumstances and provisions to reduce paid-up capital without necessity of approval by the Tribunal.
Following are the cases which amount to reduction of share capital but where no approval/confirmation by the Tribunal is necessary –
(a) Forfeiture of shares – If the Articles authorize, a company may forfeit shares for non-payment of calls and such forfeiture does not require Tribunal approval. The forfeiture shall be completed in a proper manner and as per regulations such as valid notice and proper procedure. Forfeiture is completed through a Board resolution and such forfeiture shall be exercised in the best interests of the company.
(b) Surrender of shares – If the Articles authorize, a registered shareholder may surrender his shares to the company. In case of surrender of shares, it has the same effect as reduction of capital. Surrender may be accepted by the company under the same circumstances where forfeiture is justified.
(c) Diminution of capital – Where the company cancels shares which have not been taken or agreed to be taken by any person (Section 61 of the Companies Act, 2013).
(d) Redemption of redeemable preference shares – As per Section 55 of the Companies Act, 2013, a company shall redeem its preference shares at maturity. There is reduction in the amount of capital, without the sanction of the Tribunal.
(e) Buy-back of its own shares – Section 68 of the Companies Act, 2013 enables a company to buy back its equity shares from existing shareholders, without the approval of the Tribunal.
Question 4.
XYZ Ltd. is going for reduction of capital, but the Board of directors of the company expects objection from some of the creditors of the company. The Board seeks your opinion as a company secretary with respect to this matter. Express your opinion in light of the provisions of Companies Act, 2013
Answer:
Reduction of capital means reduction of issued, subscribed and paid-up capital of a company. A company limited by shares or limited by guarantee, and having share capital may reduce its paid-up capital.
As per Section 66 of the Companies Act, 2013, a company can reduce its paid-up equity capital, if the following conditions are satisfied –
- authorized by the Articles of Association,
- passing a special resolution,
- confirmation by the National Company Law Tribunal (NCLT)
- no arrears in repayment of deposits or interest thereon
Once XYZ Ltd. passes the special resolution for the reduction of capital, it shall apply to the National Company Law Tribunal (NCLT) for the confirmation of resolution.
The application shall be accompanied by list of creditors certified by the MD or any two directors and a declaration that deposits and/or interest is not in arrears.
The creditors having any debt or claim against the company are entitled to object. If any creditor objects, then either his consent is obtained or he should be paid off or his payment be secured.
prior to confirming the capital reduction u/s 66 of the Companies Act, 2013, the Tribunal shall consider the rights of the creditors and ensure protection of such rights.
The Tribunal shall give notice of every such application to the creditors, Central Govt, ROC and SEBI (for listed companies).
The Tribunal shall consider the representations, if any, made to it by Central Govt., ROC, and the SEBI and the creditors within a period of 3 months from the date of receipt of the notice. If no representation has been received from them within the said period, it shall be presumed that they have no objection to the reduction.
Further, the Tribunal shall sanction the reduction of share capital after ensuring the accounting treatment conforms with the accounting standards (u/s 133 of the Companies Act, 2013)
Tribunal shall ensure that capital reduction is fair, legal and equitable,i.e. protection of interests of creditors, shareholders and public. [British & American Trustee Corp. vs. Cooper].
Question 5.
The National Company Law Tribunal (NCLT) has confirmed the reduction of share capital of MGF Ltd. Explain when the reduction of share capital will take place as per the Companies Act, 2013.
Answer:
As per Section 66 of the Companies Act, 2013, a company can reduce its share capital through the approval of shareholders through special resolution and confirmation of the NCLT.
- A company shall apply to the NCLT (Form RSC-1), where the application shall be supported by list of creditors and declaration stating that deposits and interest thereon is not in arrears.
- The Tribunal shall inform the ROC, Central Govt, and creditors about capital reduction activity for inviting their representations. The Tribunal shall ensure protection of creditors, shareholders and public.
- Once Tribunal is satisfied about legal compliances and accounting treatment it shall confirm the scheme
In the given case, MGF Ltd. shall deliver a certified copy of the Tribunal order to the ROC (within 30 days) showing the following –
(a) the amount of share capital;
(b) the number of shares into which it is to be divided;
(c) the amount of each share and
(d) the amount, if any, at the date of registration deemed to be paid-up on each share.
On receiving the order, the ROC shall register the same and issue a certificate to that effect. The reduction of share capital takes effect only on registration of the order. The RoC will then issue a certificate of registration which will be conclusive evidence about capital reduction.
Question 6.
Persuasion Performers Ltd. has defaulted in payment of certain instalments of Bank Loan during the year 2012. On 17th October 2016, Board passed a resolution to convene a general meeting to pass a resolution authorizing Board to buy back its shares to the extent not more than 20% of paid-up capital and reserves. It is noted by the Board that the default to Bank was accidental and that has been made good by July 2013.
The Extraordinary General Meeting has been scheduled for Friday 18th November 2016. Can you help the Board as to legality of the proposal stating any other aspect to be looked, that prohibits buy-back of securities?
Answer:
As per Section 68 of the Companies Act, 2013, a company can buy back its shares and securities.
Buy-back is a procedure where a company goes back to the holder of its shares/specified securities and offers to purchase from them the shares/specified securities that they hold.
As per Section 70 of the Companies Act, 2013, a company not allowed buy back its own securities, if it has defaulted in following cases –
- Repayment of deposits or interest accrued thereon; or
- Redemption of debentures/preference shares; or
- Payment of dividend; or
- Repayment of any term loan or interest payable thereon to any financial institution or bank
However, the above restriction does not apply of three years have elapsed after such default has ceased to subsist. In the given case, Percussion Performers Ltd. defaulted in payment of instalments of Bank loan in 2012 and the same was rectified by July 2013. The company is planning a buy-back in October 2016, which is after three (3) years from the rectification of the default.
Hence, the Board action to initiate a buy-back is valid, since they have complied with the provisions laid down by Section 70.
Further, the company shall ensure the following –
- Only fully paid-up shares are available for buy-back
- debt-equity ratio does not exceed 2:1 post-buy-back
- buy-back process needs to be completed within 12 months of authorization.
- shares bought back need to be destroyed within 7 days of the completion of buy-back.
- maintain a register of shares bought back.
- file a return of buy-back with the ROC.
Question 7.
Saravana Synthetics Ltd. passed a resolution for reduction of capital that has been approved by the Tribunal. Being aggrieved on the valuation process employed Mr. Suman, a shareholder, holding about 4% of total capital, appealed against the said order. Will he be successful?
Answer:
As per Section 66 of the Companies Act, 2013, a company can reduce its issued, subscribed and paid-up capital if following conditions are satisfied –
- authorized by the Articles of Association,
- passing special resolution in general meeting,
- approval of the NCLT, and
- no default in repayment of deposits and payment of interest thereon.
In the given case, Saravana Synthetics Ltd. passed a resolution for reduction of capital and the Tribunal has approved the same. Where a capital reduction u/s 66 is approved by the Tribunal and the ROC registers the same, it is conclusive evidence and cannot be challenged.
In the case of Chanderbhan Gandhi vs. Reckitt Benckiser, it was held that in the absence of any fault in the reasoning of the single judge approving the reduction of capital, valuation of shares, the appeal by a sole shareholder is rejected. Hence, in the given instance, the objection raised by Mr. Suman shall not be successful.
Question 8.
Negotiated deals, private arrangements and spot transaction methods of buyback of shares are allowed under SEBI (Buy-Back of Securities) Regulation, 1998.
Answer:
As per Section 68 of the Companies Act, 2013, a company can buy back its shares and securities. Buy-back is a procedure where a company goes back to the holder of its shares/specified securities and offers to purchase from them the shares/specified securities that they hold.
Regulation 4 of SEBI (Buy-back of Securities) Regulations, 2018 does not permit buy-back through negotiated deals (of and on stock exchange), private arrangement and spot transactions.
According to Regulation 4 of the SEBI (Buy-back of Securities) Regulation, 2018, a company may buy back its own shares or other specified securities by any one of the following methods:
- from the existing shareholders or other specified securities holders on a proportionate basis through the tender offer;
- from the open market through book-building process or stock exchange
- from odd-lot holders.
No offer of buy-back for 15% or more of paid-up capital and free reserves, shall be made from the open market.
Question 9.
Securities premium can be utilized for reducing share capital.
Answer:
As per Section 66 of the Companies Act, 2013, a company can reduce its issued, subscribed and paid-up capital if following conditions are satisfied –
- authorized by the Articles of Association,
- passing special resolution in general meeting,
- approval of the NCLT, and
- no default in repayment of deposits and payment of interest thereon
However, in the case of Alembic Ltd., it was held that securities premiums can be utilized for reducing share capital. Utilization of securities premium and general reserve for reduction of share capital is permissible if:
- There is no diminution of liabilities, or
- There is no repayment of paid-up capital, or
- There is no reduction of issued, subscribed or paid-up share capital.
Question 10.
Enumerate certain circumstances that necessitate financial restructuring, being part of Internal Corporate Restructuring.
Answer:
Basically, there are two sources of funds, viz. own funds and borrowed funds. Own funds, ie. internally generated funds are an important element of capital structure.
However, internal funds can be insufficient for facilitating rapid growth and prosperity. Hence, the gap between funds required and generated internally is met through external financing
A balance of debt and equity is essential for smooth financial manage¬ment and maximizing shareholders’ wealth. Financial restructuring of a company is a re-arrangement of its financial structure to make the company’s finances more balanced.
Financial restructuring is considered by the Board of directors of a company in the following circumstances –
- Need for additional working capital to meet market demand for company’s products;
- When the company is unable to meet its current commitments;
- When the company is unable to obtain further credit from suppliers of raw materials, stores,
- bought out components etc. and from other parties like those doing job work for the company.
- When the company is unable to utilize its full production capacity due to lack of liquid funds.
Question 11.
What corrective measures a Company can take to restructure its internal finance having noticed symptoms of either undercapitalization or overcapitalization?
Answer:
A balance of debt and equity is essential for smooth financial management and maximizing shareholders’ wealth. Thus, a company may face financial difficulties due to disequilibrium between debt-equity funds.
Financial restructuring of a company is a re-arrangement of its financial structure to make the company’s finances more balanced. In simple words, it is an adjustment of debt equity ratio.
Under-capitalization is a scenario where there is shortage of funds as compared to scale and size of the operating cycle. It is also known as over-trading.
On identifying symptoms of under-capitalisation, the company should resort to one or more of the following corrective measures:
- Injecting more capital either through right /preferential or public issue;
- Issuing bonds and debentures;
- Accepting deposits from directors, shareholders, relatives, business associates or public
- Reducing the dividend per share split up at the shares; e. Issuance of bonus share will reduce both the dividend per share and earnings per share.
Over-capitalization is a situation where there are excess funds invested in a business as compared to size of the operating cycle. It is also known as under-trading. On identifying symptoms of over-capitalisation, the company should use any of the following corrective measures:
- Buy-back of own shares
- Reduction of capital by paying surplus capital to shareholders
- Repaying loans to financial institutions, banks, etc.
- Repaying fixed deposits taken from public, etc.
- Redeeming its debentures, bonds, etc.
- Preference shares may be redeemed through capital reduction scheme.
Question 12.
“Optimum capitalization is desired to maintain robust financial health of an enterprise.” Identify the symptoms of overcapitalization or undercapitalization.
Answer:
Capitalization denotes the level of capital employed in a business as compared to the trading activity or scale of business operations. Capital employed means the aggregate of all long-term sources of funds, i.e. equity capital, preference capital, debentures, term loans etc.
Under-capitalization is observed in case of strong companies, which use less long-term capital but use short-term funds to meet their liquidity needs.
Symptoms of under-capitalization include the following –
- Need for additional working capital to meet market demand for company’s products
- When the company is unable to meet its current commitments
- When a company is unable to obtain further credit from suppliers of raw materials, stores, bought out components etc. and from other parties like those doing job work.
- When a company is unable to utilize its full production capacity due to less liquidity.
Over-Capitalization
Over-capitalization is a situation where there are excess funds invested in a business as compared to size of the operating cycle. It is also known as under-trading.
Further, a company is said to be over-capitalized when its earnings are not sufficient to justify a fair return on the amount of capital employed in the business. Sometimes, it is possible that a company may have sufficient funds and yet have low earnings.
Symptoms of over-capitalisation include –
- exorbitant promotion expenses,
- liberalised dividend policy,
- high rate of inflation,
- inadequate provision of depreciation,
- high corporate taxes etc.
Question 13.
“Measuring shareholders’ value” is the objective of Good Corporate Governance. Comment on the statement, how buyback of shares achieves it.
Answer:
Corporate governance is an essential element of company management. The statutes consisting of the Companies Act, 2013 and the SEBI always strive to achieve best corporate practices.
Considering shareholders interests, transparency and upholding corporate governance principles are the basis for creating corporate value.
When a company has surplus funds for which it does not have good areas for investment, assuring an average return on capital employed and earnings per share (EPS), the company’s financial structure requires balancing. It is a case of over-capitalization.
The Board of directors of such company has to make a thorough study into the financial structure, the precise reasons for its restructuring and the mode of restructuring which would be suitable to the requirements of the company in the given circumstances.
One of the methods of financial restructuring is buy-back of its own securities. Buy-back results in the return of the shareholder’s money to the shareholders and a reduction of the floating stock of the company’s securities in the market.
Following are the positive effects of buy-back, in relation to maximizing shareholder value –
- increase earnings per share (EPS)
- improve return on capital employed (ROCE), return on equity (ROE)
- compensate shareholders in case of low trading volumes, ie. to provide exit route
- return surplus cash to shareholders.
- achieve optimum capital structure, ie. a mix of borrowing and own funds.
- reduce cost of capital, thereby increasing future profitability
- ensure optimum allocation of funds generated, by avoiding any unproductive investments.
Question 14.
The reduction of share capital can result in extinguishment of class of shares.
Answer:
In the case of Siel Ltd., a scheme of amalgamation and arrangement involved reduction of share capital by extinguishment of shares of a particular class. The reduction was approved by the majority of shareholders and creditors of the Transferee Company.
The High Court, (now NCLT) approved the reduction and extinguishment of a portion of share capital was held to be permissible as no one was prejudicially affected. Hence, reduction of capital can result in the extinguishment of entire class of shares.
Question 15.
What do you understand by overcapitalized company? Discuss the corrective measures required to be undertaken by an over-capitalised company.
Answer:
A balance of debt and equity is essential for smooth financial management and maximizing shareholders’ wealth. Thus, a company may face financial difficulties due to disequilibrium between debt-equity funds.
Financial restructuring of a company is a re-arrangement of its financial structure to make the company’s finances more balanced. In simple words, it is an adjustment of debt equity ratio
Over-capitalization is a situation where there are excess funds invested in a business as compared to size of the operating cycle. It is also known as under-trading.
On identifying symptoms of over-capitalisation, the company should use any of the following corrective measures:
- Buy-back of own shares
- Reduction of capital by paying surplus capital to shareholders
- Repaying loans to financial institutions, banks, etc.
- Repaying fixed deposits taken from public, etc.
- Redeeming its debentures, bonds, etc.
- Preference shares may be redeemed through capital reduction scheme.
Question 16.
Elucidate the obligations of a merchant banker as per Regulation 20 of SEBI (Buyback of Securities) Regulations, 1998.
Answer:
In case of listed companies, along with Companies Act, 2013, there shall be compliance of the SEBI (Buy-Back of Securities) Regulations, 1998.
As per SEBI (Buy-Back of Securities) Regulations, 1998, a company shall appoint a registered Merchant Banker to comply with all the legal compliance, management of escrow account, making public disclosures etc.
Following are the obligations of a Merchant Banker (Regulation 20) –
- the company is able to implement the offer
- the provision relating to escrow account has been made
- firm arrangements for monies for payment to fulfil obligations under the offer are in place
- the public announcement of buy-back is made and letter of offer has been filed with SEBI
- furnish to SEBI, a due diligence certificate which should accompany the draft letter of offer
- ensure that the contents of the public announcement of offer as well as the letter of offer are true, fair and adequate and quoting the source wherever necessary
- ensure due compliance of Sections 68,69 and 70 of the Companies Act, 2013
- inform the bank with whom the escrow has been deposited to release the balance amount to the company send a final report to SEBI in the specified form, within 15 days from the date of closure of the buy-back offer.
Question 17.
Circumstances which prohibit buy-back of shares or other specified securities under the Companies Act, 2013.
Answer:
As per Section 68 of the Companies Act, 2013, a company can buy back its shares and securities.
Buy-back is a procedure where a company goes back to the holder of its shares/specified securities and offers to purchase from them the shares/specified securities that they hold.
As per Section 70 of the Companies Act, 2013, a company not allowed buy back its own securities, if it has defaulted in following cases –
- Repayment of deposits or interest accrued thereon or
- Redemption of debentures/preference shares or
- Payment of dividend or
- Repayment of any term loan or interest payable thereon to any financial institution or bank, However, the above restriction does not apply of three years have elapsed after such default has ceased to subsist.
Further, a company shall not buy back its securities if –
- it has not filed the annual return with the Registrar of Companies
- it has not paid dividend within the due date
- it has not prepared its financial statements as per Schedule III of Companies Act, 2013.
No company shall, directly or indirectly, purchase its own shares or other specified securities through any subsidiary or investment company.
Question 18.
Mo offer of buy-back shall be made within a period of 180 days from the date of Board meeting or meeting of shareholders, as the case may be, in respect of the preceding offer of buy-back.
Answer:
As per Section 68 of the Companies Act, 2013, a company can buy back its shares and securities.
Buy-back is a procedure where a company goes back to the holder of its shares/specified securities and offers to purchase from them the shares/specified securities that they hold.
The Board of Directors can approve a buy-back of equity shares up to 10% of the aggregate of paid-up equity capital, free reserves and security premium account.
Shareholders’ special resolution is required if amount of buy-back is up to 25% of the aggregate of the paid-up equity capital, free reserves and security premium.
As per Section 68(2) of the Companies Act, 2013, no offer of buy-back shall be made within a period of one year from the date of the closure of the preceding offer of buy-back, if any.
Question 19.
Certain securities are not available for the buy-back purposes. Comment.
Answer:
As per Section 68 of the Companies Act, 2013, a company can buy back its shares and securities.
Buy-back is a procedure where a company goes back to the holder of its shares/specified securities and offers to purchase from them the shares/specified securities that they hold.
However, following securities are not available for buy-back –
- Party paid-up equity shares;
- Securities in lock-in period as per SEBI (ICDR) Regulations, 2018 are not available for buyback until the lock-in period expires.
- Non-transferable securities, Le. securities which are under lien or are pledged or restricted by Court/Tribunal.
- Disputed securities kept in abeyance, e. securities which are under dispute and have kept in abeyance.